Unwelcome Surprises for Annuity Investors

By Elizabeth O'Brien

Any viewer of the evening news knows the pitch: secure retirement income for life, guaranteed, with the purchase of an annuity. Variable annuities sweeten the deal a little further, offering benefits that, in some cases, can grow over time. But under pressures related to the financial crisis and its aftermath, some of the companies that sell variable annuities are making their terms less generous—and many investors are learning that the “guarantee” of a guaranteed payment comes with a lot of caveats.

In one of the most recent such changes, Prudential Annuities recently suspended existing investors’ ability to add money to certain variable annuity contracts—meaning some policyholders will get smaller payouts than they may have planned. While other annuity issuers have made similar moves, Prudential’s changes have been widely publicized because it’s one of the industry’s biggest providers, with $120 billion in assets in variable annuities.

Variable annuities combine a portfolio of investments with an insurance component that guarantees a variety of benefits, depending on the product. Among the popular options: guaranteed growth rates on the contract holder’s benefit amount, and guaranteed minimum withdrawal amounts after the policyholder decides to “annuitize,” or convert the policy’s benefit amount into an income stream.

Variable annuities have proved popular among retirees who are nervous about the stock market and are hunting for higher yields: Since the beginning of 2007, variable-annuity sales have averaged around $150 billion a year.

The problem: The cost to insurance companies of hedging their market risk have gone up since the financial crisis, while the money the companies earn in the bond market has fallen with lower interest rates.“These products were built and priced in a very different environment,” said David Blanchett, head of retirement research at Morningstar.

This squeeze has made it harder for annuity providers to sustain the generous guarantees they offered a few years ago. For example, policies that might have offered a 7 percent growth rate would now offer as little as 5 percent, said Robert Luna, CEO of SureVest Capital Management in Phoenix, Arizona. Guaranteed payout rates that might have been as high as 7 percent have shrunk to 4.5 percent or lower.

The affected Prudential Annuity contracts guaranteed a certain growth rate—in some cases, up to 7 percent—in the policyholders’ benefits accounts. Suspending new contributions to that account limits the amount of new money that can grow there.

“The decision to suspend acceptance of additional purchase payments was made as a direct result of the persistent low interest rate environment that has impacted our industry,” a Prudential spokeswoman said in an e-mailed statement.

A company’s ability to change the terms of a variable annuity would always appear in the annuity’s prospectus, said Moshe Milevsky, finance professor at the Schulich School of Business at York University and an annuity expert. That prospectus can rival a phone book in size, of course, and it’d be easy for consumers to miss such declarations if their advisers don’t bring them to their attention. Still, “Honestly, I don’t see the egregiousness of it,” Milevsky said of Prudential’s move.

What should investors do if their annuity provider changes its benefit terms? While each investor’s situation is different, it generally doesn’t make sense to bail out of policies issued before the financial crisis, because even with some terms reduced they’re likely more generous than the policies available today.

Luna said he’s recently seen some insurance companies offering to waive the surrender charges and pay a premium for customers as an incentive for them to exit annuities issued before the crisis—in effect, a buyout. He’s counseled against taking those offers, however, since investors would have a hard time finding an offer as good as the one they’re being bought out of.

Comments (5 of 5)

How is suspending existing investors’ ability to add money to certain variable annuity contracts anything to do with changing terms? It’s not like they changed the terms on the existing money already invested. Now THAT would be a big issue. But if they can’t afford to continue to sell that particular product right now, they should be able to stop selling it.

9:34 pm September 23, 2012

Henry wrote:

When the deflationary crash hits some annuities won’t be able to pay. You can bet on it. Google for CONQUER THE CRASH KONDRATIEFF WAVE to understand the deflation risk.

Above all it is important to determine the credit worthiness of the underwriter for your Annuity Contract. Insurance companies may, like all other businesses, may fall victum to many negative factors. These elements can alter the ability to pay out when the time arrives to collect.
Do not simply check when signing up, keep checking every six months thereafter. Access information from your state insurance department, the rating agencies, and read the financials in business publications. Remember…caveat emptor.

9:12 am September 20, 2012

Chandler & Company wrote:

Even if they suspend the addition of new money, most insurance companies still allow ongoing contributions to their annuities if it is structured as an IRA. Its right there in the prospectus.

Furthermore, many annuities provide that you will recieve either the guaranteed payout rate or the rate that is in effect when you annuitize (whichever is higher). So, if your guaranteed a 4.5% payout but 25 years from now its 7%, you’ll get the 7%. Again, read the prospectus.

Search Encore20

About Encore

Encore examines the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities and priorities of today’s retirees. The blog also explores news that affects retirement, from the Wall Street Journal Digital Network and around the web. Lead bloggers are reporter Catey Hill and senior editor Jeremy Olshan. Other contributors include The Wall Street Journal’s retirement columnists Glenn Ruffenach and Anne Tergesen; the Director for the Center for Retirement Research at Boston College, Alicia Munnell; and the Director of Research for Pinnacle Advisory Group, Michael Kitces, CFP.